By Randy Neumann
Here we are at the beginning of the New Year, a time when wishes are often granted. What follows is a wish list of employer-sponsored retirement plans. If you are an employer, you may want to give an appropriate gift to your employees. If you are an employee, you may want to talk to your boss about one of the following employer-sponsored retirement plans. We’ll begin with the smallest plan and move up to the largest.
The SIMPLE plan – a loose fitting acronym for the Savings Incentive Match Plan for Employees of Small Employers – is a recent creation that is based on the Individual Retirement Account (IRA). The requirements for the employer are minimal. To be eligible for a SIMPLE, the company must have 100 or fewer employees, and not have another retirement plan in place.
A SIMPLE plan is easy to create; it has very low administrative costs and no annual IRS reporting requirements (for which there is a fee). Traditional IRA’s are set up for each eligible employee who can contribute to the IRA on a tax-deferred basis via payroll deductions. Employers can either fully match the contributions of plan participants up to 3% of a participant’s annual compensation or… contribute a 2% fixed percentage of all eligible employees’ pay. The maximum employee contribution to a SIMPLE is $11,500 and, if you are over age 50, you can make a catch-up contribution of $2,500.
The next plan to discuss is a SEP–Simplified Employee Pension plan. This plan allows you to put a lot more money away than you can with a SIMPLE. You can have a SEP along with another type of retirement plan at your business simultaneously. A SEP allows business owners and employees annual tax-deductible contributions equal to 25% of compensation (if you have a corporation) or 20% of self-employment income (for a sole proprietor).
Now, percentages are one thing, dollars are quite another. You can sock away the above percentages into a SEP to a dollar maximum of $49,000.
Next comes the solo 401(k). Yes, you can have a 401(k) when you are self-employed. A business owner may establish one and include their spouse in the plan, provided the spouse is an employee of the business, and there are no other employees.
A solo 401(k) throws in a profit-sharing twist on the standard 401(k). Solo 401(ks may be funded by the employee (deferred compensation) and the business (a percentage of profit). As an employee of your business, you can contribute an amount up to the standard yearly 401(k) contribution limit plus catch-up contributions if you are 50 or older. Additionally, solo 401(k) plans allow you to make tax-deductible profit-sharing contributions equal to 25% of your compensation (corporate entity) or 20% of self-employment income (sole proprietor). Again, you are subject to the $49,000 annual max. It is even possible to have a solo Roth 401(k). These plans require a TPA (third-party administrator).
Profit-sharing plans. Here’s one way to compete with larger companies for prime employees. Contributions are usually deductible at both the federal and state level, with contribution limits equivalent to a SEP. However, contributions aren’t mandatory as they are for most other plans. If your business has a bad year, you don’t have to make any contributions. The assets placed within the plan grow tax-deferred. Again, annual tax-deductible contributions may be made according to the 25/20% rule depending on your business entity and will have the $49,000 max.
The newest kid on the street is the “new comparability plan.” This is a hybrid plan that skews the benefits of the plan to senior or key employees more than others. The classic situation for this plan is when you have a small business whose multiple owners take home similar earnings, but are of different ages. The plan must be tested annually to meet Internal Revenue Code nondiscrimination requirements. It allows different levels of compensation to different groups within a small business.
Which plan is right for you? It depends. There is a lot of variability available in qualified retirement plans, so you don’t have to buy one “off the rack”; instead you can have one custom made. And, like a suit, down the road you can have it let out or taken in when necessary.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual. Randy Neumann CFP® is a registered representative with securities and insurance offered through LPL Financial. Member FINRA/SIPC. He can be reached at 12 Route 17N, Suite 115, Paramus, 201-291-9000.